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Stocks that were favoured by socially conscious investors saw weaker losses during the COVID-19 pandemic market crash, according to research from Imperial College Business School.

Socially conscious investors are investors who incorporate non-economic guidelines into their decision-making, on issues such as environmental responsibility, human rights or religious views.

In the paper, Socially Conscious Investors: Mitigating Stock Market Losses During the COVID-19 Crash, which is available on  SSRN, Dr Ruoke Yang, a financial economist at Imperial College Business School and Iva Koci, a teaching fellow at Imperial, found that socially preferred stocks experienced superior returns, lower returns volatility, and a smaller decline in market valuations since March 2020, with these effects largely disappearing afterwards in the immediate months that followed.

According to the authors, socially responsible investors tend to pay a cost in terms of stock returns to satisfy their social responsibility criteria as they drive up share prices of the firms they prefer. However, the researchers investigated whether there was an actual scenario in which such demand led socially preferred stocks to enjoy higher returns.

The COVID-19 pandemic has provided an excellent setting to study this question as it created a plausible external negative shock to the U.S. stock market and the economy at large and caused many investors to rush to sell off their stocks. For stocks held by enough investors for reasons owing to social motivations, these investments may experience superior stock market performance from a weaker decline in market valuations during the market crash.

The researchers examined non-financial firms that belong to the S&P 500, which consist of large and prominent businesses that collectively represent around 75 percent of the total market capitalization in the U.S. Socially responsible investor demand is measured using data on mutual funds and institutional investor holdings. Socially conscious mutual funds are identified by Morningstar as mutual funds which incorporate non-economic guidelines in their investment mandates.

Given the lack of a similar list for the wider base of institutional investors as a whole, the researchers link firm-level corporate social responsibility ratings to institutional investor holdings to obtain a set of fund-level social responsibility scores.

The researchers found that a one standard deviation increase in socially conscious mutual ownership corresponded to approximately a three percent reduction in returns loss at the monthly level.

In stark contrast, no differences are found with respect to sales, gross profitability, and operating income as well as expectations about the long-term growth rate of earnings per share. This provides evidence against the possibility that investor social preferences somehow coincided with choosing firms whose businesses on average weathered the crisis better.

Ruoke Yang said: “While being preferred by these socially conscious investors was not enough to escape the crash of March 2020, it did help by mitigating some of the stock market losses, compared to other stocks, as indicated by a weaker drop in market valuations, which suggests that socially conscious investors can act as a moderating force in the stock market in a time of crisis.”

The researchers’ work is in line with recent studies by other economists that reveal how socially responsible investors place a lower importance on the financial aspects of their investments during normal times. This factor is important for explaining why firms with greater socially responsible investor demand saw a lower drop in their market valuations during the crash.

These findings have important implications for firms and investors, showing how although socially conscious investments sacrifice returns during normal times, they can also generate a reversal of fortune during bad times.

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